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Chapter 22: Q18E. (page 1312)

Peter Henning Tool Company’s December 31 year-end financial statements contained the following errors.

December 31, 2017 December 31, 2018

Ending inventory \(9,600 understated \)8,100 overstated

Depreciation expense \(2,300 understated —

An insurance premium of \)66,000 was prepaid in 2017 covering the years 2017, 2018, and 2019. The entire amount was charged to expense in 2017.

In addition, on December 31, 2018, fully depreciated machinery was sold for $15,000 cash, but the entry was not recorded until 2019.

There were no other errors during 2017 or 2018, and no corrections have been made for any of the errors. (Ignore income tax considerations.)

Instructions

(a) Compute the total effect of the errors on 2018 net income.

(b) Compute the total effect of the errors on the amount of Henning’s working capital at December 31, 2018.

(c) Compute the total effect of the errors on the balance of Henning’s retained earnings at December 31, 2018.

Short Answer

Expert verified

The effect on net income is $24,700, the effect on working capital is $28,900, and the effect on retained earnings will be $26,600.

Step by step solution

01

Computation of part A

Effect on 2015 net income over (under) statement

Understatement of 2017 ending Inventory

9,600

Overstatement of 2018 ending Inventory

8,100

Expensing of insurance premium in 2017

22,000

Failure to record sale of the fully depreciated machine in 2018

-15,000

The total effect of errors on net income

24,700

02

Computation of part B

Effect on working capital over (under) statement

Overstatement of 2018 ending Inventory

-8,100

Expensing of insurance premium in 2017 (prepaid Insurance)

-22,000

Sale of fully depreciated machine unrecorded

-15,000

Total effect on working capital (understated)

-28,900

03

Computation of part C

Effect on retained earnings over (under) statement

Overstatement of 2018 ending inventory

8,100

Understatement of depreciation expense in 2017

2,300

Expensing of insurance premium in 2017

-22,000

Failure to record sale of a fully depreciated machine in 2018

-15,000

Total effect on retained earnings (understated)

-26,600

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Most popular questions from this chapter

(Accounting for Accounting Changes and Errors) Listed below are various types of accounting changes and errors.

______ 1. Change in a plant asset’s salvage value.

______ 2. Change due to overstatement of inventory.

______ 3. Change from sum-of-the-years’-digits to straight-line method of depreciation.

______ 4. Change from presenting unconsolidated to consolidated financial statements.

______ 5. Change from LIFO to FIFO inventory method.

______ 6. Change in the rate used to compute warranty costs.

______ 7. Change from an unacceptable accounting principle to an acceptable accounting principle.

______ 8. Change in a patent’s amortization period.

______ 9. Change from completed-contract to percentage-of-completion method on construction contracts.

______ 10. Change from FIFO to average-cost inventory method.

Instructions For each change or error, indicate how it would be accounted for using the following code letters:

(a) Accounted for prospectively.

(b) Accounted for retrospectively.

(c) Neither of the above.

Question: (Analysis of Various Accounting Changes and Errors) Mathys Inc. has recently hired a new independent auditor, Karen Ogleby, who says she wants “to get everything straightened out.” Consequently, she has proposed the following accounting changes in connection with Mathys Inc.’s 2017 financial statements.

1. At December 31, 2016, the client had a receivable of \(820,000 from Hendricks Inc. on its balance sheet. Hendricks Inc. has gone bankrupt, and no recovery is expected. The client proposes to write off the receivable as a prior period item.

2. The client proposes the following changes in depreciation policies.

(a) For office furniture and fixtures, it proposes to change from a 10-year useful life to an 8-year life. If this change had been made in prior years, retained earnings at December 31, 2016, would have been \)250,000 less. The effect of the change on 2017 income alone is a reduction of \(60,000.

(b) For its new equipment in the leasing division, the client proposes to adopt the sum-of-the-years’-digits depreciation method. The client had never used SYD before. The first year the client operated a leasing division was 2017. If straight-line depreciation were used, 2017 income would be \)110,000 greater.

3. In preparing its 2016 statements, one of the client’s bookkeepers overstated ending inventory by \(235,000 because of a mathematical error. The client proposes to treat this item as a prior period adjustment.

4. In the past, the client has spread preproduction costs in its furniture division over 5 years. Because its latest furniture is of the “fad” type, it appears that the largest volume of sales will occur during the first 2 years after introduction. Consequently, the client proposes to amortize preproduction costs on a per-unit basis, which will result in expensing most of such costs during the first 2 years after the furniture’s introduction. If the new accounting method had been used prior to 2017, retained earnings at December 31, 2016, would have been \)375,000 less.

5. For the nursery division, the client proposes to switch from FIFO to LIFO inventories because it believes that LIFO will provide a better matching of current costs with revenues. The effect of making this change on 2017 earnings will be an increase of \(320,000. The client says that the effect of the change on December 31, 2016, retained earnings cannot be determined.

6. To achieve an appropriate recognition of revenues and expenses in its building construction division, the client proposes to switch from the completed-contract method of accounting to the percentage-of-completion method. Had the percentage-of-completion method been employed in all prior years, retained earnings at December 31, 2016, would have been \)1,075,000 greater.

Instructions

(a) For each of the changes described above, decide whether:

(1) The change involves an accounting principle, accounting estimate, or correction of an error.

(2) Restatement of opening retained earnings is required.

(b) What would be the proper adjustment to the December 31, 2016, retained earnings?

On December 31, 2017, before the books were closed, the management and accountants of Madrasa Inc. made the following determinations about three pieces of equipment.

1. Equipment A was purchased January 2, 2014. It originally cost \(540,000 and, for depreciation purposes, the straight-line method was originally chosen. The asset was originally expected to be useful for 10 years and have a zero salvage value. In 2017, the decision was made to change the depreciation method from straight-line to sum-of-the-years’-digits, and the estimates relating to useful life and salvage value remained unchanged.

2. Equipment B was purchased January 3, 2013. It originally cost \)180,000 and, for depreciation purposes, the straight-line method was chosen. The asset was originally expected to be useful for 15 years and have a zero residual value. In 2017, the decision was made to shorten the total life of this asset to 9 years and to estimate the residual value at \(3,000.

3. Equipment C was purchased January 5, 2013. The asset’s original cost was \)160,000, and this amount was entirely expensed in 2013. This particular asset has a 10-year useful life and no residual value. The straight-line method was chosen for depreciation purposes.

Additional data:

1. Income in 2017 before depreciation expense amounted to \(400,000.

2. Depreciation expense on assets other than A, B, and C totaled \)55,000 in 2017.

3. Income in 2016 was reported at \(370,000.

4. Ignore all income tax effects.

5. 100,000 shares of common stock were outstanding in 2016 and 2017.

Instructions

(a) Prepare all necessary entries in 2017 to record these determinations.

(b) Prepare comparative retained earnings statements for Madrasa Inc. for 2016 and 2017. The company had retained earnings of \)200,000 at December 31, 2015.

In January 2017, installation costs of \(6,000 on new machinery were charged to Maintenance and Repairs Expense. Other costs of this machinery of \)30,000 were correctly recorded and have been depreciated using the straight-line method with an estimated life of 10 years and no salvage value. At December 31, 2018, it is decided that the machinery has a remaining useful life of 20 years, starting with January 1, 2018. What entry(ies) should be made in 2018 to correctly record transactions related to machinery, assuming the machinery has no salvage value? The books have not been closed for 2018 and depreciation expense has not yet been recorded for 2018.

You have been engaged to review the financial statements of Gottschalk Corporation. In the course of your examination, you conclude that the bookkeeper hired during the current year is not doing a good job. You notice a number of irregularities as follows.

1. Year-end wages payable of \(3,400 were not recorded because the bookkeeper thought that “they were immaterial.”

2. Accrued vacation pay for the year of \)31,100 was not recorded because the bookkeeper “never heard that you had to do it.”

3. Insurance for a 12-month period purchased on November 1 of this year was charged to insurance expense in the amount of \(2,640 because “the amount of the check is about the same every year.” 4. Reported sales revenue for the year is \)2,120,000. This includes all sales taxes collected for the year. The sales tax rate is 6%. Because the sales tax is forwarded to the state’s Department of Revenue, the Sales Tax Expense account is debited. The bookkeeper thought that “the sales tax is a selling expense.” At the end of the current year, the balance in the Sales Tax Expense account is $103,400.

Instructions Prepare the necessary correcting entries, assuming that Gottschalk uses a calendar-year basis.
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